<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 333-52263*
MICHAEL PETROLEUM CORPORATION
(Exact name of registrant as specified in its charter)
Texas 76-0510239
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
13101 Northwest Freeway
Suite 320
Houston, Texas 77040
(Address of principal executive offices including zip code)
(713) 895-0909
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
* The Commission File Number refers to a Form S-4 Registration Statement filed
by the Registrant under the Securities Act of 1933 which was declared effective
on July 22, 1998.
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
As of November 12, 1999, there were 10,000 shares of the Registrant's Common
Stock, par value $0.10 per share, outstanding.
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MICHAEL PETROLEUM CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 385 $ 430
Accounts receivable 10,450 6,366
Note receivable 1,036 1,500
Prepaid expenses and other 551 655
------------- ------------
Total current assets 12,422 8,951
Oil and gas properties, (successful efforts method) at cost 176,968 155,867
Less: accumulated depreciation, depletion and
amortization (36,878) (24,989)
------------- ------------
140,090 130,878
Other assets 5,210 7,453
------------- ------------
TOTAL ASSETS $ 157,722 $ 147,282
============= ============
LIABILITIES AND STOCKHOLDER'S DEFICIT
Current liabilities:
Accounts payable $ 11,521 $ 8,925
Accrued liabilities 9,013 4,630
Current portion of long-term debt 156,051 41
------------- ------------
Total current liabilities 176,585 13,596
Long-term debt 10 144,842
------------- ------------
Total liabilities 176,595 158,438
Commitments and contingencies
Stockholder's deficit:
Preferred stock ($.10 par value, 50,000,000 shares authorized,
no shares issued and outstanding) -- --
Common stock ($.10 par value, 100,000,000 shares
authorized, 10,000 shares issued and outstanding) 1 1
Additional paid-in capital 610 610
Accumulated deficit (19,484) (11,767)
------------- ------------
Total stockholder's deficit (18,873) (11,156)
------------- ------------
TOTAL LIABILITIES AND STOCKHOLDER'S DEFICIT $ 157,722 $ 147,282
============= ============
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS.
2
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MICHAEL PETROLEUM CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS OF DOLLARS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------ ------------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues:
Oil and natural gas sales $ 10,310 $ 6,749 $ 25,310 $ 16,446
Operating expenses:
Production costs 1,483 1,233 4,355 2,833
Exploration 35 39 109 118
Depreciation, depletion and
amortization
4,090 3,921 11,913 8,420
General and administrative 639 294 1,759 811
-------- -------- -------- --------
6,247 5,487 18,136 12,182
-------- -------- -------- --------
Operating income 4,063 1,262 7,174 4,264
-------- -------- -------- --------
Other income (expense):
Interest income and other 5 61 (423) 275
Interest expense (4,332) (4,052) (12,592) (8,469)
-------- -------- -------- --------
(4,327) (3,991) (13,015) (8,194)
-------- -------- -------- --------
Loss before income taxes and extraordinary
item (264) (2,729) (5,841) (3,930)
Income tax expense (benefit) before
extraordinary item - (955) 1,876 (1,376)
-------- -------- -------- --------
Net loss before extraordinary item (264) (1,774) (7,717) (2,554)
Extraordinary item: extinguishment of debt
(net of tax of $285) - - - (531)
-------- -------- -------- --------
Net loss $ (264) $ (1,774) $ (7,717) $ (3,085)
======== ======== ======== ========
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS.
3
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MICHAEL PETROLEUM CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS OF DOLLARS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30,
---------------------------
1999 1998
---------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (7,717) $ (3,085)
Adjustments to reconcile net loss to
net cash provided by operating activities:
Depreciation, depletion and amortization 11,913 8,420
Allowance for bad debts 518 --
Gain on sale of oil and natural gas properties -- (50)
Increase in deferred tax valuation allowance 1,876 --
Deferred income tax benefit -- (1,376)
Extraordinary item - extinguishment of debt -- 470
Amortization of debt issuance costs 612 414
Amortization of deferred loss on early termination
of commodity swap agreement 374 464
Amortization of discount of debt 179 146
Changes in operating assets and liabilities:
Accounts and notes receivable (4,139) (4,333)
Prepaid expenses and other 55 (2,021)
Accounts payable 908 3,423
Accrued liabilities 4,383 7,855
Other 9 35
---------- ----------
Net cash provided by operating activities 8,971 10,362
---------- ----------
Cash flows from investing activities:
Additions to oil and natural gas properties (19,437) (99,002)
Proceeds from the sale of oil and natural gas properties 150
Prepaid natural gas contract as consideration
for non-producing oil and gas properties -- (9,994)
---------- ----------
Net cash used in investing activities (19,437) (108,846)
---------- ----------
Cash flows from financing activities:
Proceeds from long-term debt 11,000 141,603
Payments on long-term debt (29) (29,305)
Additions to deferred loan costs -- (5,552)
Additions to deferred costs (550) --
---------- ----------
Net cash provided by financing activities 10,421 106,746
---------- ----------
Net (decrease) increase in cash and cash equivalents (45) 8,262
Cash and cash equivalents, beginning of period 430 782
---------- ----------
Cash and cash equivalents, end of period $ 385 $ 9,044
========== ==========
Non-cash transactions:
Changes in accounts payable related to capital expenditures $ 1,688 --
Non-producing oil and gas properties acquired through
delivery of natural gas -- $ 3,743
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS.
4
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MICHAEL PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
Michael Petroleum Corporation, a Texas corporation (the "Company") is a
wholly owned subsidiary of Michael Holdings, Inc., a Texas corporation. The
consolidated financial statements included herein have been prepared by the
Company and are unaudited, and do not contain all information required
by generally accepted accounting principles. In the opinion of
management, all material adjustments, consisting of normal recurring
adjustments, considered necessary to present fairly the results of
operations have been included. Due to seasonal fluctuations, the results
of operations for the interim periods are not necessarily indicative of
operating results for the entire fiscal year. The consolidated financial
statements in this Form 10-Q should be read in conjunction with the
audited consolidated financial statements and notes thereto included in
the Company's Annual Report on Form 10-K for the year ended December 31,
1998.
2. LONG-TERM DEBT AND LIQUIDITY
In April 1998, the Company issued $135 million 11 1/2% Senior Notes due
2005 (the "Senior Notes") and in May 1998 entered into a four-year $50
million credit facility (the "Credit Facility") with Christiania Bank og
KreditKasse ("Christiania") in which the initial borrowing base was $30
million.
The Credit Facility borrowing base was to be redetermined semiannually by
Christiania based on the Company's proved oil and natural gas reserves.
Effective April 1, 1999, the borrowing base was reduced to $23 million. The
effective interest rate under the Credit Facility for the year ended
December 31, 1998 and the nine months ended September 30, 1999 was 6.8% and
8.3%, respectively. The Company and Christiania have entered into two
amendments and executed two waivers of financial covenant violations to the
Credit Agreement during 1999, including an amendment requiring the
principal amount outstanding to be decreased by monthly mandatory
reductions in the borrowing base of $1.5 million per month effective
October 31, 1999. Effective September 20, 1999, Christiania resumed
charging the default rate of interest, increasing the interest rate an
additional 2% per annum on the outstanding balance. The Company has paid
interest accrued as of October 31, 1999, but has not paid the principal
reduction amount due October 31, 1999, and is in default under the
terms of the Credit Facility.
Beginning in the second quarter of 1999, representatives of the Company and
its financial advisor have met with certain holders of the Senior Notes to
seek financial restructuring alternatives. An interest payment on the
Senior Notes of approximately $7.8 million was due on October 1, 1999, but
not paid by the Company. The indenture covering the Senior Notes provides
for a 30-day grace period before an event of default exists as a result of
the nonpayment of interest. The 30-day grace period expired on October 31,
1999 without payment of interest on the Senior Notes, and, as a result, an
Event of Default has occurred under the Indenture with respect to the
Senior Notes. The Indenture provides that in the event of an Event of
Default, the entire indebtedness under the Senior Notes may be declared due
and payable. The Company is currently seeking an agreement-in-principle
with holders of the Senior Notes to forbear from exercising their remedies,
pending an agreement to effect a consensual restructuring or alternative
transaction concerning the Company and its indebtedness. No assurances can
be given that any such agreement can be reached outside of bankruptcy, or
if so, its ultimate terms and conditions. The Company is continuing to
negotiate with holders of Senior Notes and Christiania in an effort to
effect a consensual restructuring of the Company's indebtedness or an
alternative transaction, which could be implemented in connection with
court-supervised bankruptcy proceedings. At September 30, 1999, the Company
had deferred approximately $545,000 of costs pertaining to the Company's
planned capital restructuring. Should the planned restructuring not occur,
this amount would be charged to operations.
Pursuant to the cross default provisions contained in the indenture
governing the Senior Notes and in the Credit Facility, a default under
either the Senior Notes or the Credit Facility constitutes a default under
the other instrument. Both the Senior Notes and the Credit Facility have
been classified as current obligations as of September 30, 1999 in the
consolidated balance sheet as a result of these events.
5
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The Company's financial statements as of September 30, 1999 have been
prepared on a going concern basis which contemplates the realization of
assets and the settlement of liabilities and commitments in the normal
course of business. These financial statements do not include any
adjustments to reflect the possible future effects on the recoverability
and classification of assets or the amounts or classification of
liabilities that may result from the outcome of these uncertainties
discussed in the preceding paragraphs. Due to the number of uncertainties
discussed above, many of which are outside the control of the Company,
there can be no assurance that the Company will be able to consummate any
operational or financial restructuring outside of bankruptcy proceedings.
3. PRO FORMA RESULTS
In March and April 1998, the Company acquired oil and gas properties
totaling approximately $89.3 million. Accordingly, revenues and expenses
from these properties have been included in the Company's statement of
operations from the date of purchase. Assuming the properties were acquired
January 1, 1998, the unaudited pro forma revenues and loss from continuing
operations for the nine months ended September 30, 1998 were $20,341,000
(unaudited) and $3,218,000 (unaudited), respectively.
4. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 requires
all derivatives to be recognized in the statement of financial position as
either assets or liabilities and measured at fair value. In addition, all
hedging relationships must be designated, reassessed and documented
pursuant to the provisions of SFAS 133. This statement was initially
effective for financial statements for fiscal years beginning after June
15, 1999. However, in June 1999, the Financial Accounting Standards Board
issued SFAS No. 137, which delayed the effective date of SFAS 133 to fiscal
years beginning after June 15, 2000. The Company has not yet completed its
evaluation of the impact of the provisions of SFAS No. 133.
5. DEFERRED INCOME TAXES
Deferred income taxes reflect the net tax effects of (a) temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes,
and (b) operating loss carryforwards. At December 31, 1998, the Company had
a net operating loss carryforward of $19.5 million. Realization of deferred
tax assets associated with the net operating loss carryforward is dependent
upon generating sufficient taxable income prior to their expiration. The
status of the Company's current and future drilling program and uncertainty
about the availability of capital resulted in uncertainty as to whether
sufficient taxable income will be available to utilize the entire net
operating loss carryforward. Therefore, a valuation allowance totaling $1.9
million was established at June 30, 1999 to provide for the portion of the
net operating loss carryforward which may not be realized. As discussed in
Note 2, the Company is in discussions with its Senior Note holders. These
discussions may result in a significant stock ownership change which would
significantly affect the timing of the utilization of the net operating
loss carryforward. The valuation allowance related to tax assets could be
further adjusted in the near term if such restructuring were to occur, as
well as changes in estimates of future taxable income.
6. SUBSEQUENT EVENTS
On October 27, 1999, Christiania terminated its two costless collar
contracts with the Company. Under the terms of the termination agreement,
the Company is required to pay Christiania approximately $1.3 million. Each
contract hedged a monthly volume of 150,000 MMbtu (pertaining to
approximately 18% of the company production) with floor prices of $1.98 and
$2.15 and ceiling prices of $2.22 and $2.36, respectively. The loss on the
terminated hedge contracts will be deferred and recognized in the
consolidated statement of operations as the underlying physical transaction
occurs.
6
<PAGE>
During October 1999, two outside directors of the Company, Bryant H. Patton
and Jack I. Tompkins, resigned.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is management's discussion and analysis of certain
significant factors that have affected certain aspects of the Company's
financial position and operating results during the periods included in the
accompanying unaudited condensed consolidated financial statements. For
supplemental information, it is suggested that this Item 2 be read in
conjunction with the corresponding section included in the Company's 1998 Annual
Report on Form 10-K (the "1998 Form 10-K") as filed with the Securities and
Exchange Commission.
GENERAL
The Company is an independent energy company engaged in the acquisition,
development and production of oil and natural gas, principally in the Lobo Trend
of South Texas. The Company began operations in 1983, and, since its inception,
increased its reserve base and production as a result of acquisitions and
development of oil and natural gas properties. In March and April 1998, the
Company completed acquisitions adding approximately 51,000 gross acres (48,400
net acres) in the Lobo Trend for an aggregate purchase price of approximately
$89.3 million. For the nine months ended September 30, 1999, the Company
participated in the drilling of 21 gross (15 net) natural gas wells, 14 gross
(12 net) of which were completed as productive wells, compared to 19 gross (14
net) natural gas wells drilled, and 15 gross (10 net) completed in the same
period of 1998.
From October 1, 1999 through November 12, 1999, the Company participated in
the drilling of 3 gross (2 net) natural gas wells, of which two were in the
process of being completed, and one was still drilling.
The Company utilizes the "successful efforts" method of accounting for its
oil and natural gas activities as described in Note 1 of the Notes to
Consolidated Financial Statements in the Company's 1998 Form 10-K.
RESULTS OF OPERATIONS
The following table summarizes production volumes, average sale prices and
operating revenues for the Company's oil and natural gas operations for the
three-month and nine-month periods ended September 30, 1999 and 1998:
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTMEBER 30,
---------------------- ----------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Production volumes:
Oil and condensate (MBbls) 35 18 90 53
Natural gas (Mmcf) 3,761 3,186 10,627 7,583
Average sales prices:
Oil and condensate (per Bbl) $ 19.08 $ 10.73 $ 15.21 $ 11.89
Natural gas (per Mcf) 2.57 2.06 2.25 2.09
Operating revenues ($ 000's):
Oil and condensate $ 663 $ 193 $ 1,369 $ 630
Natural gas 9,647 6,556 23,941 15,816
-------- -------- -------- --------
Total $10,310 $ 6,749 $25,310 $16,446
======== ======== ======== ========
</TABLE>
7
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COMPARISON OF THREE MONTH PERIODS ENDED SEPTEMBER 30, 1999 AND 1998
Oil and natural gas revenues for the three months ended September 30, 1999
increased 54% to $10.3 million from $6.7 million for the three months ended
September 30, 1998. Production volumes for oil and natural gas for the second
quarter ended September 30, 1999 increased 20% to 3,968 MMcfe from 3,294 MMcfe
for the third quarter of 1998. Average natural gas prices increased 25% to $2.57
per Mcf for 1999 from $2.06 per Mcf for 1998. The increase in oil and natural
gas production was a result of the new wells brought on line resulting from the
Company's drilling program.
Oil and natural gas production costs for the three months ended September
30, 1999 increased 25% to $1.5 million from $1.2 million for the three months
ended September 30, 1998, primarily due to the increase in the number of
producing wells as a result of the Company's development program. Production
costs per equivalent unit remained unchanged at $0.37 per Mcfe for the three
months ended September 30, 1999, compared to the same period in 1998.
Depreciation, depletion and amortization ("DD&A") expense for the three
months ended September 30, 1999 increased 5% to $4.1 million from $3.9 million
for the same period in 1998. The increase in DD&A expense was due to higher
productive volumes. The DD&A rate decreased from $1.19 per Mcfe for the three
months ended September 30, 1998 to $1.03 per Mcfe for the same period in 1999.
The higher rate in the prior year included a $725,000 impairment charge
recognized for the three months ended September 30, 1998. The 1999 DD&A rate
included cost overruns and below average reserves per well on certain wells
drilled in 1998 and 1999.
General and administrative expenses for the three months ended September
30, 1999 increased 117% to $639,000 from $294,000 for the three months ended
September 30, 1998 due to salaries and related benefits for new professional
employees, and increases in insurance, engineering, legal and professional fees
and office expenses. General and administrative expenses per equivalent unit
increased to $0.16 per Mcfe for the three months ended September 30, 1999 from
$0.09 per Mcfe for the three months ended September 30, 1998.
Interest expense, net of capitalized interest, and loan amortization costs
for the three months ended September 30, 1999 increased 5% to $4.3 million from
$4.1 million for the same period in 1998. The increase was due to the higher
level of outstanding debt on the Credit Facility for the three months ended
September 30, 1999 compared to the same period of 1998.
There was no income tax benefit for the three months ended September 30,
1999, as a valuation allowance of $91,000 was recorded by the Company as
compared to an income tax benefit of $955,000 for the same period in 1998. The
valuation allowance recorded by the Company is the sole reconciling item between
the expected tax benefit and the recorded tax amount. The Company's net
operating loss carryforward was partially reserved as of September 30, 1999 as
the status of the current and future drilling program and uncertainty about the
availability of capital resulted in uncertainty as to whether sufficient taxable
income will be available to utilize the entire net operating loss carryforward.
Any restructuring of the Company's indebtedness may result in a significant
stock ownership change which would significantly affect the timing of the
utilization of the net operating loss carryforward. The valuation allowance
related to tax assets could be adjusted in the near term if such restructuring
were to occur, as well as for changes in estimates of future taxable income.
At September 30, 1999, the Company had deferred approximately $545,000 of
costs pertaining to the Company's planned capital restructuring discussed under
"Liquidity and Capital Resources." Should the planned restructuring not occur,
this amount would be charged to operations.
The net loss for the three months ended September 30, 1999 was $264,000
compared to a net loss of $1.8 million for the three months ended September 30,
1998, primarily as a result of the factors discussed above.
COMPARISON OF NINE MONTH PERIODS ENDED SEPTEMBER 30, 1999 AND 1998
Oil and natural gas revenues for the nine months ended September 30, 1999
increased 54% to $25.3 million from $16.4 million for the nine months ended
September 30, 1998. Production volumes for oil and natural gas for
8
<PAGE>
the nine months ended September 30, 1999 increased 41% to 11,166 MMcfe from
7,901 MMcfe for the first nine months of 1998. Average natural gas prices
increased 8% to $2.25 per Mcf for nine months ended September 30, 1999 from
$2.09 per Mcf for the same period in 1998. The increase in natural gas
production was due to the acquisitions of additional properties in 1998, plus
new wells brought on line resulting from the Company's drilling program.
Oil and natural gas production costs for the nine months ended September
30, 1999 increased 57% to $4.4 million from $2.8 million for the nine months
ended September 30, 1998 primarily due to the increase in the number of
producing wells. The production costs per equivalent unit increased to $0.39 per
Mcfe for the nine months ended September 30, 1999 from $0.36 per Mcfe for the
nine months ended September 30, 1998.
DD&A expense for the nine months ended September 30, 1999 increased 42% to
$11.9 million from $8.4 million for the same period in 1998. The increase in
DD&A expense was due to higher production volumes. The DD&A rate decreased from
$1.07 per Mcfe for the nine months ended September 30, 1998 to $1.03 per Mcfe
for the same period in 1999. The higher rate in the prior year included
impairment charges of $1.4 million that were recognized for the nine months
ended September 30, 1998. These 1998 impairment charges were due to development
dry holes drilled on oil and gas leases that incurred a reduction in the
estimated proved reserves. The 1999 DD&A rate included cost overruns and below
average reserves per well on certain wells drilled in 1998 and 1999.
General and administrative expenses for the nine months ended September 30,
1999 increased 122% to $1.8 million from $811,000 for the nine months ended
September 30, 1998 due to salaries and related benefits for new professional
employees, plus the increases in insurance, engineering, legal and professional
fees, and office expenses. General and administrative expenses per equivalent
unit increased to $0.16 per Mcfe for the nine months ended September 30, 1999
from $0.10 per Mcfe for the nine months ended September 30, 1998.
Interest expense, net of capitalized interest, and loan amortization costs
for the nine months ended September 30, 1999 increased 48% to $12.6 million from
$8.5 million for the same period in 1998. The increase was due to the higher
level of outstanding debt for the nine months ended September 30, 1999 compared
to the same period of 1998.
For the nine months ended September 30, 1999, the Company recorded in
interest income and other, an allowance for bad debts totaling $518,000
pertaining to a $1.5 million note receivable from a Texas limited liability
company. The reserve was established as a result of a contract cancellation by a
third party with a joint venture partner of the Texas limited liability company.
If the cancellation matter is not resolved, additional bad debt charges may be
incurred.
The income tax expense was $1.9 million for the nine months ended September
30, 1999 as a valuation allowance of $4.0 million was recorded by the Company as
compared to an income tax benefit of $1.4 million for the same period in 1998.
The valuation allowance recorded by the Company is the sole reconciling item
between the expected tax benefit and the recorded tax amount. The Company's net
operating loss carryforward was partially reserved as of September 30, 1999 as
the status of the current and future drilling program and uncertainty about the
availability of capital resulted in uncertainty as to whether sufficient taxable
income will be available to utilize the entire net operating loss carryforward.
Any restructuring of the Company's indebtedness may result in a significant
stock ownership change which would significantly affect the timing of the
utilization of the net operating loss carryforward. The valuation allowance
related to tax assets could be adjusted in the near term due to changes in
estimates of future taxable income.
The extraordinary loss of $531,000 (net of the income tax benefit of
$285,000) for the nine months ended September 30, 1998 was due to an
extinguishment of the previous credit facility. No extraordinary items were
recognized in the nine months ended September 30, 1999.
The net loss for the nine months ended September 30, 1999 was $7.7 million
compared to a loss of $3.1 million for the nine months ended September 30, 1998,
primarily as a result of the factors discussed above.
9
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
In April 1998, the Company issued $135 million of Senior Notes and in
May 1998 entered into a Credit Facility with Christiania ("Christiania") in
which the initial borrowing base was $30 million.
The Credit Facility borrowing base was to be redetermined semiannually by
Christiania based on the Company's proved oil and natural gas reserves.
Effective April 1, 1999, the borrowing base was reduced to $23 million. The
Company and Christiania have entered into two amendments and executed two
waivers of debt covenant violations to the Credit Agreement during 1999,
including an amendment requiring the principal amount outstanding to be
decreased by monthly mandatory reductions in the borrowing base of $1.5 million
per month effective October 31, 1999. Effective September 20, 1999, Christiania
resumed charging the default rate of interest, increasing the interest rate an
additional 2% per annum on the outstanding balance. The Company has paid
interest accrued as of October 31, 1999, but has not paid the principal
reduction amount due October 31, 1999, and is in default under the terms of
the Credit Facility.
Beginning in the second quarter of 1999, representatives of the Company
and its financial advisor have met with certain holders of the Senior Notes
to seek financial restructuring alternatives. An interest payment on the
Senior Notes of approximately $7.8 million was due on October 1, 1999, but
not paid by the Company. The indenture covering the Senior Notes provides for
a 30-day grace period before an event of default exists as a result of the
nonpayment of interest. The 30-day grace period expired on October 31, 1999
without payment of interest on the Senior Notes, and, as a result, an Event
of Default occurred under the Indenture with respect to the Senior Notes. The
Indenture provides that in the event of an Event of Default, the entire
indebtedness under the Senior Notes may be declared due and payable. The
Company is currently seeking an agreement -in- principle with holders of the
Senior Notes to forbear from exercising their remedies, pending an agreement
to effect a consensual restructuring or alternative transaction concerning
the Company and its indebtedness. No assurances can be given that any such
agreements can be reached outside of bankruptcy, or if so, their ultimate
terms and conditions. The Company is continuing to negotiate with holders of
Senior Notes and Christiania in an effort to effect a consensual
restructuring of the Company's indebtedness or an alternative transaction,
which could be implemented in connection with court-supervised bankruptcy
proceedings.
Pursuant to the cross default provisions contained in the indenture
governing the Senior Notes and in the Credit Facility, a default under either
the Senior Notes or the Credit Facility constitutes a default under the other
instrument. Both the Senior Notes and the Credit Facility have been classified
as current obligations of the Company as of September 30, 1999 as a result of
these events.
At September 30, 1999, the Company had cash and cash equivalents of
$385,000, consisting primarily of short-term money market investments, compared
to $430,000 at December 31, 1998. The working capital deficit was $164.2 million
at September 30, 1999 compared to a working capital deficit of $4.7 million at
December 31, 1998, primarily due to the classification of the Senior Notes and
the indebtedness under the Credit Facility as a current obligation.
Cash flows provided by operating activities from the Company's operations
were approximately $9.0 million and $10.4 million for the nine months ended
September 30, 1999 and 1998, respectively. The decrease in operating cash flows
for the nine months ended September 30, 1999 over the same period in 1998 was
primarily due to timing differences regarding collection of receivables and
payment of obligations.
Cash flows used in investing activities by the Company were $19.4 million
and $108.8 million for the nine months ended September 30, 1999 and 1998,
respectively. Property additions during 1998 totaling approximately $90.0
million resulted primarily from the 1998 acquisitions and the drilling and
development activities described above.
Cash flows provided by financing activities were $10.4 million and $106.7
million for the nine months ended September 30, 1999 and 1998, respectively.
During the nine months ended September 30, 1998, the Senior Notes were issued to
fund the property acquisitions, whereas funds received in 1999 pertained to
amounts borrowed under the Credit Facility.
The Company's outstanding indebtedness (and the payment and other
defaults under the terms of the Senior Notes and Credit Facility) and the
Company's current lack of funding available from other sources have effected
10
<PAGE>
the Company's operations, including (i) an increase in the Company's
vulnerability to adverse changes in industry conditions due to its leveraged
position, and (ii) stress on the Company's ability to fund its developmental
and other capital expenditures.
The Company's financial statements as of September 30, 1999 have been
prepared on a going concern basis which contemplates the realization of assets
and the settlement of liabilities and commitments in the normal course of
business. These financial statements do not include any adjustments to reflect
the possible future effects on the recoverability and classification of assets
or the amounts or classification of liabilities that may result from the outcome
of these uncertainties discussed in the preceding paragraphs. Due to the number
of uncertainties discussed above, many of which are outside the control of the
Company, there can be no assurance that the Company will be able to consummate
any operational or financial restructuring outside of bankruptcy proceedings.
CAPITAL EXPENDITURES
Capital expenditures for the nine months ended September 30, 1999 totaled
$21.1 million compared to $108.9 million in 1998.
The Company expects to continue to experience working capital requirements
due to the Company's current development program. The Company's estimated
capital expenditure budget for 1999 is $25.0 million. Substantially all of the
1999 capital expenditures have been used to fund drilling activities, lease
acquisitions and 3-D seismic surveys in the Company's project areas. The Company
anticipates drilling a total of 26 gross (19 net) wells in 1999. Because
borrowings under the Credit Facility or other sources are not currently
available, cash flows from operations will not allow the Company to fully
implement its present development drilling strategy. The Company will require
capital from sources other than the Credit Facility in order for the Company to
fully implement its development drilling strategy for the foreseeable future. It
is possible that minimal amounts of debtor-in-possession financing may be made
available to the Company to partially fund its capital expenditures if the
Company became subject to court-supervised bankruptcy proceedings; however, no
assurances could be given that such financing would be made available, and if
so, on terms favorable to the Company. In the event that additional capital is
not available, capital expenditures are expected to be further reduced. Actual
amounts to be expended by the Company will depend upon a number of factors,
including the extent of cash flows from operations available, the ability of the
Company to negotiate the terms of a restructuring of its indebtedness or an
alternative transaction with its current lenders and creditors, and potentially,
the approval of the bankruptcy court.
FINANCING ARRANGEMENTS
CREDIT FACILITY
In May 1998, the Company entered into its Credit Facility with Christiania
as lender and administrative agent. The Credit Facility provided for loans in an
outstanding principal amount not to exceed $50.0 million at any one time,
subject to a borrowing base to be determined semi-annually (each April and
October) by the administrative agent (the initial borrowing base was $30.0
million), and the issuance of letters of credit in an outstanding face amount
not to exceed $6.0 million at any one time with the face amount of all
outstanding letters of credit reducing, dollar-for-dollar, the availability of
loans under the Credit Facility.
The Credit Facility borrowing base was to be redetermined semiannually by
Christiania based on the Company's proved oil and natural gas reserves.
Effective April 1, 1999, the borrowing base was reduced to $23 million. The
Company and Christiania have entered into two amendments and executed two
waivers of debt covenant violations to the Credit Agreement during 1999,
including an amendment requiring the principal amount outstanding to be
decreased by monthly mandatory reductions in the borrowing base of $1.5 million
per month effective October 31, 1999. Effective September 20, 1999, Christiania
resumed charging the default rate of interest, increasing the interest rate an
additional 2% per annum on the outstanding balance. The Company has paid
interest accrued as of October 31, 1999, but has not paid the principal
reduction amount due October 31, 1999, and is in default under the terms of
the Credit Facility.
11
<PAGE>
SENIOR NOTES
The Indenture governing the Senior Notes contains certain covenants
that, among other things, limit the ability of the Company to incur
additional indebtedness, pay dividends, repurchase equity interests or make
other Restricted Payments (as defined in the Indenture), create liens, enter
into transactions with affiliates, sell assets or enter into certain mergers
and consolidations. The Company is continuing to negotiate with holders of
Senior Notes and Christiania in an effort to effect a consensual
restructuring of the Company's indebtedness or an alternative transaction,
which could be implemented in connection with court-supervised bankruptcy
proceedings. (see "Liquidity and Capital Resources").
HEDGING ACTIVITIES
In an effort to achieve more predictable cash flows and earnings and reduce
the effects of volatility of the price of oil and natural gas on the Company's
operations, the Company has hedged in the past, and in the future expects to
hedge oil and natural gas prices through the use of swap contracts, put options
and costless collars. While the use of these hedging arrangements limits the
downside-risk of adverse price movements, it also limits future gains from
favorable movements. The Company accounts for these transactions as hedging
activities and, accordingly, gains and losses are included in oil and natural
gas revenues in the periods in which the related production occurs. The Company
does not engage in hedging arrangements in which the production amounts are in
excess of the Company's actual production.
The fair value of the put option and costless collars in effect at
September 30, 1999 and 1998 were approximately ($2.7 million) and $1.0
million, respectively. All prices are relative to the Houston Ship Channel
Index. The costless collars have a price range from a floor of $1.98 per
MMBtu to a ceiling of $2.385 per MMBtu through April 30, 2000 pertaining to
approximately 55% of the Company's estimated natural gas production. The
Company has also granted an option for another costless collar to be in
effect from May 1, 2000 to October 31, 2000. Under the option, the Company
would agree to hedge a monthly volume of 300,000 MMbtu with a floor price of
$2.10 and a ceiling price of $2.40 per MMBtu. The option must be exercised
within two business days of April 30, 2000.
On October 27, 1999, Christiania terminated its two costless collar
contracts with the Company. Under the terms of the termination agreement, the
Company is required to pay Christiania approximately $1.3 million. Each
contract hedged a monthly volume of 150,000 MMbtu (pertaining to
approximately 18% of the Company's production) with floor prices of $1.98 and
$2.15 and ceiling prices of $2.22 and $2.36, respectively. After giving
effect to the termination of these contracts, the Company currently has put
options and costless collars in effect pertaining to approximately 44% of the
Company's estimated natural gas production. The loss on the terminated hedge
contracts will be deferred and recognized in the consolidated statement of
operations as the underlying physical transaction occurs.
CAUTIONARY STATEMENT FOR PURPOSES OF FORWARD LOOKING STATEMENTS
Item 2. "Management's Discussion and Analysis of Financial Condition and
Results of Operations" of this Quarterly Report on Form 10-Q contains
projections and other forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934. These statements can be
identified by the use of forward-looking terminology, such as "believes,"
"expects," "may," "should" or "anticipates" or the negative thereof or
comparable terminology, or by discussions of strategy that involve risks and
uncertainties. In addition, all statements other than statements of
historical facts included in this Quarterly Report, including, without
limitation, statements regarding the results of any debt restructuring or
other alternatives for the Company, possible outcomes of the Company's
negotiations with its creditors, achievement of the Company's drilling and
development program objectives, amendment of or waiver under the Company's
credit facilities, availability of additional sources of capital funding,
future governmental regulation, oil and natural gas reserves, future drilling
and development opportunities and operations, future acquisitions, future
production of oil and natural gas (and the prices thereof and the costs
therefor), anticipated results of hedging activities, the need for and
availability of additional capital, future capital expenditures, Year 2000
compliance issues, and future net cash flows, are forward-looking statements
and may contain certain information concerning financial results, economic
conditions, trends and known uncertainties. Such statements reflect the
Company's current views with respect to future events and financial performance,
and involve risks and uncertainties. Actual results could differ materially
from those projected in the forward-looking statements as a result of these
various
12
<PAGE>
risks and uncertainties, including, without limitation, (i) risks associated
with the Company's substantial leverage, (ii) factors such as natural gas
price fluctuations and markets, uncertainties of estimates of reserves and
future net revenues, competition in the oil and natural gas industry, risks
associated with oil and natural gas operations, risks associated with future
acquisitions, risks associated with the Company's future capital requirements
and the availability of sources of capital and regulatory and environmental
risks, (iii) adverse changes to the properties and leases acquired in 1998 or
the failure of the Company to achieve the anticipated benefits of such
acquisitions, (iv) the extent of "Year 2000" compliance by the Company's
suppliers and customers and the Company's information and embedded
technologies, and (v) adverse changes in the market for the Company's oil and
natural gas production. For a more detailed description of these and certain
other risks associated with the Company's operations, see "Risk Factors" in
the 1998 Form 10-K.
YEAR 2000 COMPLIANCE
Many computer systems have been designed using software that processes
transactions using two digits to represent the year. This type of software will
generally require modifications to function properly with dates after December
31, 1999. The same issue applies to microprocessors embedded in machinery and
equipment, such as gas compressors and pipeline meters. The impact of failing to
identify and correct this problem could be significant to the Company's ability
to operate and report results, as well as potentially exposing the Company to
third party liability.
The Company has substantially completed making necessary modifications to
its internal information computer systems in preparation for the Year 2000. The
Company estimates that the total related costs for its Year 2000 project will be
approximately $10,000, funded by cash from operations. Actual costs to date have
been less than $10,000.
The Company has completed its review of the Year 2000 compliance status of
field equipment, including compressor stations, gas control systems and data
logging equipment. Accordingly, the Company has determined that these systems
are Year 2000 compliant.
The Company has identified significant third parties whose Year 2000
compliance could affect the Company and is still in the process of formally
inquiring about their Year 2000 status. The Company has received responses to
less than 50% of its inquiries. Despite its efforts to assure that such third
parties are Year 2000 compliant, the Company cannot provide assurance that all
significant third parties will achieve compliance in a timely manner. A third
party's failure to achieve Year 2000 compliance could result in a material
adverse effect on the Company's operations and cash flow. The potential effect
of Year 2000 non-compliance by third parties is currently unknown.
Project costs and the timetable for Year 2000 compliance are based on
management's best estimates. In developing these estimates, assumptions were
made regarding future events including, among other things, the availability of
certain resources and the continued cooperation of the Company's customers and
suppliers. Actual costs and timing may differ from management's estimates due to
unexpected difficulties in obtaining trained personnel, locating and correcting
relevant computer code and other factors. Management does not expect the costs
of the Company's Year 2000 project to have a material adverse effect on the
Company's financial position, results of operations or cash flows. Presently,
based on information available, the Company cannot conclude that any failure of
the Company or third parties to achieve Year 2000 compliance will not adversely
effect the Company.
The Company has designated personnel responsible to not only identify and
respond to these issues, but also to develop a contingency plan in the event
that a problem arises after the turn of the century. The Company is currently
identifying appropriate contingency plans in the event of potential problems
resulting from failure of the Company's or significant third party computer
systems on January 1, 2000. Specific contingency plans have been developed in
response to the results of testing that is substantially completed, as well as
the assessed probability and risk of system or equipment failure. These
contingency plans include installing backup computer systems or equipment,
temporarily replacing systems or equipment with manual processes, and
identifying alternative suppliers, serve companies and purchasers. The Company
expects these plans to be completed by early December 1999.
13
<PAGE>
The most likely worst-case scenario of any Year 2000 non-compliance
problems affecting the Company would involve the disruption of utilities,
particularly electricity in the Company's headquarters and in the field. It is
believed that any disruption of utilities would be corrected in a relatively
short amount of time. However, a long-term disruption could adversely affect the
Company's business reputation, results of operation and financial condition.
EFFECTS OF INFLATION AND CHANGES IN PRICE
The Company's results of operations and cash flows are affected by changes
in oil and natural gas prices. If the price of oil and natural gas increases
(decreases), there could be a corresponding increase (decrease) in the operating
costs that the Company is required to bear for operations, as well as an
increase (decrease) in revenues. Inflation has had only a minimal effect on the
Company.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes regarding market risk and the
Company's derivative instruments during the nine months ended September 30,
1999 other than that noted below. Accordingly, no additional disclosures have
been provided in accordance with Regulation S-K, Item 305(c). The derivative
instruments consist of costless collars that have a price range from a floor
of $1.98 per MMBtu to a ceiling of $2.385 per MMBtu through April 30, 2000
pertaining to approximately 55% of the Company's estimated natural gas
production. The Company has also granted an option for another costless
collar to be in effect from May 1, 2000 to October 31, 2000. Under the
option, the Company would agree to hedge a monthly volume of 300,000 MMbtu
with a floor price of $2.10 and a ceiling price of $2.40 per MMBtu. The
option must be exercised within two business days of April 30, 2000.
On October 27, 1999, Christiania terminated its two costless collar
contracts with the Company. Under the terms of the termination agreement, the
Company is required to pay Christiania approximately $1.3 million. Each contract
hedged a monthly volume of 150,000 MMbtu (pertaining to approximately 18% of the
Company's production) with floor prices of $1.98 and $2.15 and ceiling prices of
$2.22 and $2.36, respectively. The loss on the terminated hedge contracts will
be deferred and recognized in the consolidated statement of operations as the
underlying physical transaction occurs.
14
<PAGE>
PART II - OTHER INFORMATION
<TABLE>
<S> <C>
Item 1. Legal Proceedings.................................................................... Not Applicable
Item 2. Changes in Securities and Use of Proceeds............................................ Not Applicable
Item 3. Defaults upon Senior Securities
The Company's Senior Notes and Credit Facility are currently in default.
See Part I, Item 2. "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Financial Arrangements."
Item 4. Submission of Matters to a Vote of Security Holders.................................. Not Applicable
Item 5. Other Information.................................................................... Not Applicable
</TABLE>
Item 6. Exhibits and Reports on Form 8-K:
(a) The following exhibits are filed as part of this report:
27.1* Financial Data Schedule.
(b) Reports on Form 8-K filed during the quarter ended September 30,
1999 and thereafter:
On August 27, 1999, the Company filed a Current Report on Form 8-K, Item 5
- "Other Events" with respect to the reporting of the Company's proved oil
and natural gas reserves as of June 30, 1999.
On September 30, 1999, the Company filed a Current Report on Form 8-K, Item
5 - "Other Events" with respect to the Company's revised debt restructuring
proposal regarding its Senior Notes.
On October 5, 1999, the Company filed a Current Report on Form 8-K, Item 5
- "Other Events" with respect to the Company's meetings with and proposals
to the unofficial committee of the holders of the Company's Senior Notes
and their financial advisors.
On October 31, 1999, the Company filed a Current Report on Form 8-K, Item 5
- "Other Events" with respect to the expiration of the 30-day grace period
resulting in an Event of Default under the Indenture governing the Senior
Notes.
* Filed herewith
15
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
MICHAEL PETROLEUM CORPORATION
(REGISTRANT)
Date November 15, 1999 By /s/ Glenn D. Hart
----------------- ------------------------------------------
Glenn D. Hart
Chief Executive Officer and Chairman
of the Board
Date November 15, 1999 By /s/ Michael G. Farmar
----------------- ------------------------------------------
Michael G. Farmar
President and Chief Operating Officer
Date November 15, 1999 By /s/ Robert L. Swanson
----------------- ------------------------------------------
Robert L. Swanson
Vice President, Finance
Date November 15, 1999 By /s/ Scott R. Sampsell
----------------- ------------------------------------------
Scott R. Sampsell
Vice President, Controller and Treasurer
16
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